Opinion

Bankers have just signed off on policies that could increase risk of another GFC

A report signed off by Reserve Bank governor Philip Lowe has endorsed the use of unconventional monetary policies in the post-crisis era. Disturbingly, however, it contains a voluminous list of material side effects and, more than a decade after the crisis, says it is too early to assess some of their long-term implications.

While the report from the Bank for International Settlements (BIS) describes the unconventional policies as valuable additions to the central banking toolbox and is largely positive in its commentary on their effectiveness, there is increasing debate within central banks about their continued deployment this distance from the crisis.

Traders are being tested by renewed volatility sparked by economic and political uncertainties.Credit:Bloomberg

With the RBA pushing the cash rate down towards zero and having admitted it has studied unconventional policies, it is not surprising that Lowe, the chairman of the global financial stability committee that produced the report, supports the use of unconventional policies, although the report does argue that they would be more effective if deployed in tandem with fiscal and prudential measures.

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With the ECB reactivating its version of unconventional policy; the Bank of Japan still (after several decades) buying financial assets and running a marginally negative short-term policy rate; and the US Federal Reserve cutting rates again and contemplating expansion of a balance sheet that was contracting last year; it would seem the key economies can’t escape from the legacies of the policies they enacted in response to the financial crisis.

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It’s also clear, and was conceded within the BIS paper, that those policies have had spillover effects to other economies, most notably emerging market economies but also small open economies such as Australia’s.

Those critical of the continuance of policies put in place in response to a financial crisis more than a decade ago place more weight on the side effects than the BIS report, which nevertheless has a very long list of them.

One obvious unintended consequence of the policies - a current topic of debate in this market - is their impact on bank net interest margins and the profitability and stability of banking systems.

Another is the distortion of pricing and risk signals that leads to inefficient allocation of credit and capital and incentives to increase leverage – the world is far more leveraged today than it was in 2008.

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The use of the policies clearly increases moral hazard and risk-taking, with markets demonstrating repeatedly that they are banking on being bailed out by central banks whenever asset valuations appear under pressure and also contributes to wealth inequality, rewarding those with financial and property assets and punishing savers.

The interaction between the central banks’ operations and the far more stringent new post-crisis prudential regimes for financial institutions also raises questions about the functioning of markets in periods of stress.

Last month’s meltdown in the US "repo’’ market (the market for short-term secured funding) was probably a good example of the unintended consequences of the post-crisis policies.

In some respects central bankers can’t be blamed for wanting to argue the case for the success of unconventional policies because for the past decade they have been left to do all the heavily lifting on their own, with no real assistance from government fiscal policies and with changes to global prudential regimes that are effectively contractionary.

Last month the "repo" shot up to as much as 10 per cent, indicating an acute shortage of cash in the system, which forced the NY Fed to intervene.Credit:Bloomberg

With the world apparently re-starting the use of unconventional monetary policies even before central banks have extricated themselves from the legacies of a decade of those policies, there is a real risk that the impacts and the threats posed by their side effects will swell and that the world will be caught within what the BIS has previously described as a "debt trap’’ with no exit.

The other disturbing aspect of the report is that it repeatedly says it is too early to assess the longer-term implications of the policies the central banks have employed.

Central bankers respond to the latest data – they respond to short-term signals – but the side-effects of their post-crisis policies have already been building for a decade and will continue to build while they maintain ultra-low or negative policy rates and keep buying bonds and other fixed interest securities to depress longer-term interest rates and suppress risk premia.

How those side-effects are unwound and how the banks extricate themselves from their policies and the legacies of those policies won’t be known until they try, but the potential for another crisis has been increased by the big surge in global leverage and the elevated asset prices the policies have encouraged.

Negative rates and quantitative easing and variations on those themes might, as the BIS report says, be useful additions to central bankers’ toolboxes but the past decade has shown they aren’t by themselves a panacea for economic ills and they bring with them potentially unpleasant side effects the longer they are in place.

Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.